Either Coverdell or 529 accounts can be used to save for college while offering tax benefits.
Coverdell accounts and 529 accounts are two financial products that you can use to save money for your children's education while offering a tax benefit. The rules on Coverdell accounts are being tightened in 2011, allowing only parents or guardians to contribute up to $500 a year (not $2,000 as before) and restricting the use of funds to college expenses only (not including grade and high school as before). The 529 accounts allow contributions of up to $13,000 a year for college expenses.
Contribution Levels
Coverdell accounts and 529 accounts are very dissimilar in terms of contribution amounts. The Coverdell account has historically allowed only parents or guardians to contribute up to $2,000 annually. In 2011, however, this amount will be reduced to a mere $500 annually. More generously, the 529 accounts allow virtually anyone to contribute up to $13,000 to the plan annually.
Investment Flexibility
Investment flexibility is an important factor to consider in deciding between a Coverdell and 529 account. The Coverdell account allows investors to reallocate the funds in the account as often as they wish. A 529 account, on the other hand, restricts investors from reallocating their funds to only two times annually.
Types of Education
Prior to 2011, the Coverdell account allowed the investor to use the funds for any educational expense, including primary (elementary and high school) education. In 2011, however, the Coverdell account can only be used for college expenses. The funds from a 529 account may only be used for college tuition or any qualified educational expense at the college level.
Income Restrictions
Anyone making over $95,000 (single) or $190,000 (married) annually cannot invest in a Coverdell account. For this reason, the 529 accounts are viewed more favorably by wealthier investors, as there are no income restrictions for contributions.
Tax Benefits
Investors can reap tax benefits by investing in either Coverdell or 529 accounts. The money that is placed into these accounts is "after-tax" money, meaning that the money has been subject to income tax. However, the money will grow tax-free and, as long as it is spent on educational expenses, will not be taxed when it is disbursed.
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